COST ACCOUNTING Subfield of accounting that records, measures, and reports information about costs MANAGERIAL ACCOUNTING When costs are used inside the organization by managers to evaluate the performance of operations or personnel or as basis for decision making FINANCIAL ACCOUNTING When costs are used for outsiders, such as shareholders/creditors to evaluate the performance of top management and make investment decisions about the organization COSTS - Sacrifice of resources - Amount of cash or cash equivalent sacrificed for goods and/or services that bring a current or future benefit to the organization. - Represented in the accounting system by outlays of cash, promises to pay cash in the future, and the expiration of the value of an asset - e.g. cost of inventory, cost of increasing sales volume, cost saved from closing a branch office. Accumulating costs - way that costs are measured and recorded - way that a cost is linked to some cost object Cost object – any item (such as product, customer, department, project, geographic region, or plant) for which costs are measured and assigned OUTPUT. represents one of the most important cost objects. PRODUCT SERVICES Goods produced by converting raw materials through the use of labor and indirect manufacturing resources such as the manufacturing plant, land, and machinery. Tasks/activities performed for a customer or an activity performed for a customer or an activity performed using an organization’s product or facilities. E.g. TVs, hamburgers, automobiles, computers, furniture, clothes, etc. Intangible, Perishable, and requires direct contact between providers and buyers E.g. service activities – medical care, accounting E.g. customer uses organization’s products or facilities – rental Expenses - Expired costs Price – revenue per unit DETERMINING PRODUCT COST PRODUCT COST/INVENTORIABLE COST/MANUFACTURING COST - Costs, both direct and indirect, of producing a product in a manufacturing firm or of acquiring a product in a merchandising firm and preparing it for sale Only costs in the PRODUCTION SECTION of the value chain are included in product costs Classified as direct materials, direct labor, and manufacturing overhead. Inventoried. First added to an inventory account and remain in inventory until sold, at which time they are transferred to cost of goods. Elements of Product Cost 1. Direct Materials - cost that can be easily and accurately traced, wherein the relationship between the cost and the object can be physically observed. - materials that are part of the final product and can be directly traced to products, because physical observation can be used to measure the quantity used by each product - Materials that are consumed in the manufacturing process and physically incorporated in the finished products - Materials that become part of a product usually are classified as direct materials. 2. Direct Labor - Labor time that is physically traceable to the products being manufactured - Labor time whose cost is sufficiently large to justify the record keeping expenses necessary to trace the costs to individual products - compensation and benefits of workers in the factory (who convert direct materials into a product) - labor that can be directly traced to the goods being produced 3. Factory Overhead - All of costs of manufacturing excluding direct materials and direct labor a) Indirect Materials - Materials, used in the manufacturing of products, which are difficult to trace to particular products in an economical way b) Indirect Labor - Labor, used in the manufacturing of products, which is difficult to trace to particular products in an economical way Is the cost of fringe benefits for the assembly line workers generally considered direct labor? Usually yes, the costs can be traced When an assembly line worker works overtime, he/she is paid a regular wage plus an overtime premium. Would most companies treat his/her regular wage as a direct labor cost? Yes, the amount of time an employee works can be traced to the products. What about the overtime premium? Treated as OH, cannot be traced to a specific product ELEMENTS OF PRODUCT COST Direct Materials Main raw material Direct Labor Factory Overhead Basic Pay-workers Indirect Material Cost of living allowance Operating 13th month pay Janitorial & Factory Regular cash Supplies equivalents of non-cash - Nails incentives - Screws - Glue Direct labor for - Sand paper manufacturing Honda - Lubricating oil Accords: - Grease Line workers, robot - Cleaning materials operators, painters, - Etc. assembly Other types of OH Depreciation on machinery, depreciation on factory building, factory insurance, utilities for factory Indirect Labor Supervisor’s fee Wages for maintenance workers Idle time Depreciation of factory plant Insurance & other property taxes of factory plant and equipment Power, light and water Telephone and mailing costs Cost of regulatory compliance (meeting safety requirements and disposal of waste materials) Factory janitors, factory supervisors, factory secretaries CALCULATING PRODUCT COST The total product cost equals the sum of direct materials, direct labor, and manufacturing overhead. TOTAL PRODUCT COST = Direct Materials Cost + Direct Labor Cost + Manufacturing Overhead Cost CALCULATING PER-UNIT COST The unit product cost equals total product cost divided by price of the number of units produced 𝑷𝑬𝑹 𝑼𝑵𝑰𝑻 𝑪𝑶𝑺𝑻 = 𝑻𝒐𝒕𝒂𝒍 𝑷𝒓𝒐𝒅𝒖𝒄𝒕 𝑪𝒐𝒔𝒕 𝑷𝒓𝒊𝒄𝒆 𝒐𝒇 𝒏𝒐. 𝒐𝒇 𝒖𝒏𝒊𝒕𝒔 𝑷𝒓𝒐𝒅𝒖𝒄𝒆𝒅 PRIME AND CONVERSION COSTS Product costs (direct materials, labor, and manufacturing overhead) can be grouped into prime and conversion costs Prime Costs Sum of direct materials cost and direct labor cost Prime cost = Direct Materials + Direct Labor Conversion Cost Sum of direct labor cost and manufacturing overhead cost Conversion cost = Direct Labor + Manufacturing Overhead Note: Prime cost and conversion cost does not equal to total product cost since direct labor is part of both costs. PERIOD COSTS - Operating expenses associated with time periods - Charged directly to the expense accounts on the assumption that their benefit is recognized entirely in the period when the cost was incurred - cost that cannot be capitalized into prepaid expenses, inventory, or fixed assets - Typically are expensed to provide economic benefit (revenues) beyond the next year, then it is recorded as an asset (capitalized) and allocated to expense through depreciation throughout this useful life Selling or Marketing Costs Costs incurred in securing orders from customers and providing customers with the finished product Cash necessary to market, distribute, and service a product or service ORDER-FILLING Process of receiving and storing inventory, and picking, packing, and shipping each order E.g. Warehousing, Transportation, orderprocessing, billing and collection of payments, customer service ORDER GETTING Order-getters are the frontline sales persons whose job is to persuade the customers to make direct purchase and acquire new customers. E.g. sales personnel, Salaries and Commissions, Advertising Administrative Costs - Executive, organizational, and clerical costs that are not related to manufacturing or marketing - Include research, development, and general administration of the organization and cannot be assigned to either selling or production - Research and Development costs are the costs associated with designing and developing new products, and must be expensed in the period incurred. NOTE: In simple words, selling transforms the goods into money, but marketing is the method of serving and satisfying customer needs. The marketing process includes the planning of a product's and service's price, promotion and distribution. Distribution cost is the total of all those expenses that the producer of a product incurs to make possible the delivery of the product from its location to the end customer's location. SELLING/MARKETING COSTS Logistics costs, insurance costs, outof-pocket expenses Sales commissions, costs of shipping products to customers, storage of finished goods, depreciation of selling equipment (cash register) Advertising, website maintenance, spending on social media ADMINISTRATIVE COSTS Research and Development Costs, Executive salaries, legal fees, printing the annual report, general accounting, rent, utilities. Insurance payments, wages and salaries for administrative and management staff other than salespeople. cost of controller’s office, office supplies depreciation on administrative building PREPARING INCOME STATEMENTS: COST OF GOODS MANUFACTURED COST OF GOODS MANUFACTURED Represents the total product cost of goods completed during the current period and transferred to finished goods inventory The cost of direct materials used in production can be derived using the ff. formula: Beginning Inventory of Materials + Purchases - Direct Materials Used in Production = Ending Inventory of Materials (1) To calculate direct materials: Beginning Inventory of Materials + Purchases - Ending Inventory = Cost of Direct Materials (2) The direct materials then used to calculate the Cost of Goods Manufactured as follows: + Direct Materials + Direct Labor + Manufacturing Overhead Costs + Beginning WIP Inventory - Ending WIP Inventory = Cost of Goods Manufactured (3) Once the direct materials are calculated, the direct labor and manufacturing overhead for the period are added to the total manufacturing cost for the period. WORK-IN-PROCESS - Cost of the partially completed goods that are still on the factory floor at the end of the time period - The total manufacturing cost for the time period for the WIP inventories must be adjusted to have the total cost of the goods that were completed and transferred from WIP inventory to finished goods inventory during the time period + Direct Materials used in Production* + Direct Labor + Manufacturing Overhead Costs = Total Manufacturing Cost for May + Beginning WIP Inventory - Ending WIP Inventory = Cost of Goods Manufactured * (1) formula to calculate direct materials COST OF GOODS SOLD - Cost of goods that were sold during the period and then transferred from finished goods inventory on the balanced sheet to COGS on the Income Statement (i.e. as an Inventory Expense) - Classified into three categories: Production, Selling, and Administration - Beginning Finished Goods Inventory + Cost of Goods Manufactured - Ending Finished Goods Inventory = Cost of Goods Sold INCOME STATEMENT: MANUFACTURING FIRM - All sales revenue and expenses attached to a time period appear on the Income Statement Expenses are separated into three categories: Production (COGS), Selling, and Administrative SALES REVENUE = PRICE x UNITS SOLD ABC COMPANY Income Statement For The Month of May Sales Revenue xxx Cost of Goods Sold (xxx) Gross Margin* xxx Less: xxx Selling Expense xxx Administrative Expense xxx Operating Income xxx GROSS MARGIN - Difference between sales revenue and COGS - Shows how much the firm is making over and above the cost of the units sold - Does not equal to operating income or profit as it is computed without subtracting selling and administrative expense - If gross margin is positive, the firm is charging prices that cover the product cost Gross Margin Percentage - A company can compare gross margin percentage with the average fir its industry to see if its experience is within the ballpark range for other firms in the industry - Varies significantly by industry 𝑮𝑹𝑶𝑺𝑺 𝑴𝑨𝑹𝑮𝑰𝑵 𝑷𝑬𝑹𝑪𝑬𝑵𝑻𝑨𝑮𝑬 = 𝑮𝒓𝒐𝒔𝒔 𝑴𝒂𝒓𝒈𝒊𝒏 𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 𝒙𝟏𝟎𝟎 𝑨𝒄𝒄𝒐𝒖𝒏𝒕 𝒊𝒏 𝑰𝒏𝒄𝒐𝒎𝒆 𝑺𝒕𝒂𝒕𝒆𝒎𝒆𝒏𝒕 𝑺𝒂𝒍𝒆𝒔 𝑹𝒆𝒗𝒆𝒏𝒖𝒆 𝒙𝟏𝟎𝟎 OPERATING INCOME - Key figure from the income statement - The profit that shows how much the owners are actually earning from the company OPERATING INCOME = GROSS MARGIN - EXPENSES INCOME STATEMENT: SERVICE FIRM - There is no product to purchase in service organization There are no beginning or ending inventories and no COGS and gross margin in the Income Statement The cost of providing services appears along with other operating expenses of the company ABC COMPANY Income Statement For The Past Month Sales Revenue xxx Less Operating Expenses: xxx Operating Income xxx Product Costs or Inventoriable Costs – costs assigned to products that were either purchased for resale (merchandising firm or retailer) or manufactured for sale (manufacturing firm) When products are sold, product costs are recognized as an expense (cost of goods sold or COGS). The costs of unsold products remain in inventory and are not expensed (i.e. not deducted from revenue in calculating net income) Period Costs – costs that are not product costs and that are associated with the period in which they are incurred Period costs such as selling and administrative costs are expensed (i.e. deducted from revenue in calculating net income) in the period they are incurred COSTS RELATED TO DECISION MAKING Opportunity Costs costs when taking one action requires giving up the opportunity to earn profits from a different action. Nike Inc. has limited production capacity. What would be Nike’s opportunity cost of accepting a special order from the military for combat boots? If Nike accepts the special order, they may not be able to produce enough product for other sales. So, Nike would lose the profit from the other sale Incremental Costs or Differential Costs additional costs incurred when choosing a certain course of action over another (Note that incremental costs can include opportunity costs) What would be Macy’s incremental costs of expanding its fragrance department and shrinking its accessories department? The costs of stocking and staffing the new fragrance area, opportunity costs of lost profit from the decrease in sales of accessories Incremental Benefits or Differential Benefits additional benefits reaped when choosing a certain course of action over another What would be Macy’s incremental benefits of expanding its fragrance department and shrinking its accessories department? Profits Macy’s expects to earn on the new fragrances it displays/stocks Sunk Costs – Costs that have been incurred and that are not affected by any current/future action What would be considered sunk cost if Macy’s decides to expand its fragrance department and shrink its accessories department? Depreciation on the building, cost of the building COMMON COSTS AND JOINT COSTS Common costs - a cost that is not attributable to a specific cost object, such as a product or process. When a common cost is associated with the manufacturing process, it is included in factory overhead and allocated to the units produced. - Costs that multiple departments in a firm might rely on, but that doesn't correlate to the production of one specific good or department activity. Joint costs - occur when one process or element results in outputting several goods. - cost incurred to produce two or more different products by processing one or more raw materials through a common production process or a series of production processes. FIXED AND VARIABLE COSTS Fixed costs - costs that remain the same regardless of production output. - Does not increase in total as output increases, and does not decrease in total as the output decreases Variable costs Costs that can change based on the amount of output produced. increases in total as output increases, and decreases in total as the output decreases In some accounting statements, the Variable costs of production are called the “Cost of Goods Sold.” COMMON COSTS JOINT COSTS - Office Supplies, - payments to suppliers, employee wages factory leases, and equipment depreciation, - rent, phone and utilities, - licenses and tax deposits, - professional services, - insurance, travel expenses, - office and other administrative supplies (Pens, paper and printers), - and marketing budgets. The processing of crude oil can result in the joint products naphtha, gasoline, jet fuel, kerosene, diesel, heavy fuel oil and asphalt Flour – Bread and pastries Milk – dairy products FIXED COSTS - Salaries, Rental payments, lease payments, loan repayments, mortgage payments, insurance payments, property taxes, - interest amortization, interest expense, - depreciation, and some utilities. VARIABLE COSTS - COGS, - Piece-rate labor, - raw materials and inputs to production, - packaging, wages, delivery costs, - credit card fees, commissions, - and certain utilities (e.g., electricity or gas to increase production capacity). DIRECT AND INDIRECT COSTS Direct costs - costs that can be connected to a specific product - cost that can be easily and accurately traced, wherein the relationship between the cost and the object can be physically observed Indirect costs - costs that cannot be easily and accurately traced - expenses involved with maintaining and running a company. DIRECT COSTS INDIRECT COSTS - Direct Labor (Wages for the production staff.) - Direct Materials (Raw materials) - software - Manufacturing supplies. - Equipment - production supervision salaries, - quality control costs, - insurance, - depreciation, - supplies, utilities, - office equipment rental, - desktop computers and cell phones. - Utilities - Marketing campaigns - Accounting and payroll software OPPORTUNITY COSTS SUNK COSTS For instance, A farmer chooses to plant wheat; the opportunity cost is planting a different crop, or an alternate use of the resources (land and farm equipment). - marketing, - research, - new software installation or equipment, - salaries and benefits, - facilities expenses OTHER COSTS AND CLASSIFICATIONS A. Opportunity costs and sunk costs Sunk Cost sometimes called a retrospective cost, refers to an investment already incurred that can't be recovered. money already spent in the past, while opportunity cost is the potential returns not earned in the future on an investment because the capital was invested elsewhere. Opportunity Cost Opportunity costs represent the potential benefits that an individual, investor, or business misses out on when choosing one alternative over another. (the profit lost when one alternative is selected over another.) The concept is useful simply as a reminder to examine all reasonable alternatives before making a decision. B. Committed costs and Discretionary costs Fixed costs can be classified as either committed costs or discretionary costs, depending on their immediate impact on the organization. (SHORT TERM) Committed (fixed) costs - costs which are fixed obligations of the business and must be incurred to maintain continuity of operations, which cannot be easily changed. Discretionary (fixed) costs - - often defined as non-essential spending/avoidable costs costs which are optional to the extent that their incurrence and value is determined by budgeting exercise of the management. This means a business or household is still able to maintain itself (survive) even if all discretionary consumer spending stops. costs or capital expenditures for a period-specific cost or a fixed asset, which can be eliminated or reduced without having an immediate impact on the reported profitability of a business. COMMITTED COSTS - investments in assets - buildings and equipment, - real estate taxes, insurance expense - some top-level manager salaries DISCRETIONARY COSTS - advertising, - research, - public relations, management development programs, and internships for students (training,) - maintenance, - R&D C. Controllable and non-controllable costs Controllable costs those over which the company has full authority. Non-controllable costs The costs are allocated by the top management to several departments or branches, and it is not controllable from the perspective of the person such as managers. For example, a manager cannot alter his own salary. Difference: Controllable cost refers to a cost that can be altered based on a business decision or need. On the other hand, uncontrollable cost refers to a cost that cannot be altered based on a personal business decision or need. While controllable costs can be altered in the short run, uncontrollable costs can be altered in the long run. D. Out of the pocket costs and budgeted costs Out-of-pocket costs - expenses incurred by employees that require a cash payment. The employer typically reimburses employees for these costs through an expense reporting and check payment system. If employees are not reimbursed for these costs, they may be able to list them as deductible expenses on their individual tax returns, which reduces their income tax liability. An employer can reduce these costs by having employees make payments using company credit cards, so that the company pays for them directly. Conversely, all non-cash expenses, such as depreciation and amortization, are not considered to be outof-pocket costs. Further, major expenditures such as for fixed assets, or planned expenditures such as for invoices submitted by suppliers are not considered to be out-of-pocket costs. Budgeted Costs - The estimate of the expenses that a company expects to spend going ahead. expenses that management estimates to pay based on forecasted revenue and sales. the budgeted cost means the total cost for a certain level of activity. The budgeting process enables you to identify and clarify your expenses. It forces you to think of ways to control these expenses and identify the expenses you need to prioritize to meet your objectives. It helps you determine what your work costs and what limitations there are so that you make realistic plans. Cost budgets also helps you avoid waste because you can see where you spend your money. - CONTROLLABLE COSTS advertising, direct labor, bonuses donations, training costs, bonuses, direct materials, donations, dues and subscriptions, employee compensation, office supplies, marketing budgets NON-CONTROLLABLE COSTS - depreciation, - insurance, - interest (?) - administrative overhead allocated - rent allocated cost that cannot be altered (only in the long run) with based on a personal business decision or a need Can be altered in the short run based on business decision or need OUT-OF-POCKET COSTS - purchase of gasoline, parking, and tolls while engaged in company business, - the cost of a business lunch with a client, - the cost of a reward card given to an employee. BUDGETED COSTS - For example, the cost budget for a project will include all expenses required to run the project, including participants' salaries and project supplies - a manufacturing cost budget might include raw materials and overhead costs. E. Capital Expenditures and Revenue Expenditures Capital expenditures - typically one-time large purchases of fixed assets that will be used for revenue generation over a longer period. These expenditures serve the purpose of increasing the capacity or capabilities of the long-term asset by either enhancing or adding new assets to the organization. These expenditures are added on the asset side of the balance sheet. Revenue Expenditure - Revenue expenditures are short-term expenses/on-going operating expenses used in the current period or typically within one year. Revenue expenditures include the expenses required to meet the ongoing operational costs of day-to-day functions of the business, and thus are essentially the same as operating expenses. These are the expenditures that neither help in the creation of assets nor in reducing the liabilities of a business. It is recurring in nature and very essential to maintain the daily operations of a business or an organization. CAPITAL EXPENDITURES - Development of buildings, vehicles, land, or machinery expected to be used for more than one year. - purchases of property, equipment, land, computers, furniture, software, and/or vehicles that help to drive benefits for the organization by increasing the operating capability. - REVENUE EXPENDITURES employee wages, pensions, insurance, taxes. subsidies, utilities, stationery, office supplies, inventory, rent, electricity, postage Capital expenditure is classified into three main forms: Expenditure made to reduce costs; Expenditure made to increase revenue; Expenditure which is justified on non-economic grounds. Revenue expenditures can be divided into two categories: 1. Expenditures for generating revenue for a business: These are the expenditures that are essential for meeting the operational cost of a business, hence these are classified as operating expenses. 2. Expenditures for maintaining revenue-generating assets: Such expenses are incurred by business towards repair and maintenance of the assets of an organization to keep them in working condition without enhancing their lifespan. Such expenses can be towards repairing and repainting of assets.
